The Closed End Fund Puzzle: One Manâ's Loss Is Another Manâ's Gain

Closed-end funds are business entities that invest in securities and financial instruments as a way of making profits and losses. Unlike other funds, closed-end funds have their number of shares fixed and as a result their share price is determined directly by the interests of buyers and sellers in the market. The famous closed-end fund puzzle kicks in because these funds often trade at a discount to their net asset value months after they are offered and traded on public exchanges.

One of the explanations for this discount is investor sentiment. Most U.S. shareholders of closed-end funds are retail investors that sometimes are not as rational as the market would like it to be. As a result, closed-end fund prices unfortunately trade away from the net asset value of their underlying holdings. Furthermore, the persistency of the closed-end fund discount can also be attributed to the enormous cost of arbitrage.  For the efficient market to work, arbitragers need to be able to replicate the fund’s portfolio and go long or short on the fund. Because some of the underlying instruments in funds are so illiquid, transaction costs for arbitragers can often be very high. It can thus often be impossible for institutional arbitragers to narrow the discount to net asset value in any given period.

As of last Friday’s market close, there are 476 listed closed-end funds on the American stock exchanges. Out of all the American-listed funds, 48 percent of them traded at a discount to net asset value of more than two percent while only 27 percent of them traded at a premium to net asset value of more than two percent. Should we believe in the efficiency of the market, then share prices of such funds should closely track the fund’s net asset value.

One man’s misfortune is sometimes another man’s gain. To take advantage of this discount to underlying assets, we have screened a list of top ten discounted funds that can be traded on the Kapitall platform:

 

1. EQUUS TOTAL RETURN INC ( EQS): The Fund’s investment objective is to maximize the total return to the Company’s stockholders in the form of current investment income and long-term capital gains by investing in the debt and equity securities of small and middle market capitalization companies that are generally not publicly traded at the time of its investment.

Trading at a 26% discount to net asset value

 

2. BOULDER GROWTH & INCOME FUND ( BIF): The Fund seeks to produce both long-term capital appreciation through investment in common stocks and high current income consistent with preservation of capital through investments in income producing securities. The Fund is concentrated in real estate related companies (RERCs), which means it must invest more than 25% of its total assets in REITs and other companies in the real estate industry.

Trading at a 24% discount to net asset value

 

3. BOULDER TOTAL RETURN FUND ( BTF): The Fund seeks to produce both income and long-term capital appreciation by investing in a portfolio of equity and debt securities. The Fund invests primarily in common stocks, including dividend paying common stocks, such as those issued by utilities, real estate investment trusts (REITs) and regulated investment companies (RICs).

Trading at a 21% discount to net asset value

 

4. DENALI FUND/THE ( DNY): The Fund seeks to produce income and long-term capital appreciation by investing in a portfolio of equity and fixed income securities. The Fund intends to focus on securities issued by companies in the financial services industry, including, but not be limited to, savings and banking institutions, mortgage banking institutions, real estate investment trusts (REITs), consumer finance companies, credit collection and related service companies, insurance companies, securities and commodity brokerage companies.

Trading at a 19% discount to net asset value

 

5. GDL FUND/THE ( GDL): The Fund will invest primarily in merger arbitrage transactions, and to a lesser extent, in corporate reorganizations involving stubs, spin-offs and liquidations. It will invest at least 80% of its assets in securities or hedging arrangements relating to companies involved in corporate transactions or reorganizations.

Trading at a 15% discount to net asset value

 

6. ADAMS EXPRESS COMPANY ( ADX): An internally-managed closed-end fund. In order to conduct the Company’s business, the Company, through its transfer agent, American Stock Transfer & Trust Company, collects and maintains certain non-public personal information about its stockholders of record with respect to their transactions in shares of its securities. The Company’s investments include common stocks and short-term investments.

Trading at a 15% discount to net asset value

 

7. THAI FUND INC ( TTF): The Fund’s investment objective is long-term capital appreciation through investment primarily in equity securities of companies organized under the laws of the Kingdom of Thailand. The Fund makes its investments in Thailand through the Thai Investment Plan (the Plan). The Fund is the sole unit holder of the Plan.

Trading at a 15% discount to net asset value

 

8. SWISS HELVETIA FUND ( SWZ): The investment objective of the Fund is to seek long-term growth of capital through investment in equity and equity-linked securities of Swiss companies. The Fund may also acquire and hold equity and equity-linked securities of non-Swiss companies in limited instances. It invests in various sectors.

Trading at a 15% discount to net asset value

 

9. TRI-CONTINENTAL CORP ( TY): The Fund’s invests primarily for the longer term, and its investment objective is to produce future growth of both capital and income, while providing reasonable current income. The Fund may invest up to 25% of its net assets in foreign investments.

Trading at a 15% discount to net asset value

10. EATON VANCE TAX-MANAGED DIVE ( ETY): The Fund’s primary investment objective is to provide current income and gains, with a secondary objective of capital appreciation. The Company invests in sectors, such as health care, information technology, financials, consumer staples, energy, industrials and materials.

Trading at a 14% discount to net asset value

 

Written by SiHien Goh. 

Did you find this list useful as a starting point for your analysis? Do you have a list requests? Leave your comments below and we’ll do our best to deliver.

 

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